Foreign Exchange Rates and Financial Statements

Milestone 3
Foreign Exchange Rates and Financial Statements
As an accountant, one should be conversant with the impact of foreign exchange rates on financial statements as well as the risks that foreign exchange pose for businesses. One of the key ways through which foreign exchange rate has on financial statements is the translational impact. To this end, businesses that operate in foreign locations must translate the financial statements from the functional to the reporting currency. Thus, fluctuations in the exchange rates mean that a business is likely to experience translational gains and translational losses that are likely to influence the reported financial figures in the financial statements. Equally, one must consider the impact of transaction exposure when accounting for transactions in foreign currency denominations (Tiwary, 2019). In such cases, a transactional impact on the financial statement emerges when the exchange rates differ between the transaction date and the settlement date. To this end, the profit reported in a financial statement may be higher or lower as the fluctuations have an impact on the foreign-denominated contracts, the value of imports, and the value of exports. Translational and transactional impacts also have an impact on the reported cash flow of a business.
In addition, it is essential to consider the impact of foreign exchange rate fluctuations on the revenues generated by a business. The movements in the exchange rate have a key influence on the overall level of competitiveness of a given business in the global markets. To this end, stronger domestic currency increases the costs of exports leading to declining revenues as the goods and services produced by a business being less competitive. Alternatively, a weaker domestic currency can result in increased competitiveness of a business leading to increased revenues. However, the profit margin may be lower in such instances if the raw materials are imported.
Foreign exchange rates introduce hedging risks to a business. In order to mitigate the negative impact of foreign exchange on financial reports, businesses make use of financial instruments such as forward contracts, swaps, and options to minimize the impact of foreign exchange fluctuations on their operations. Hedging risks emerge in the sense that poor hedging decisions are likely to lead to losses and inadequate hedging may lead to losses or erode profitability (Pobric, 2019). In addition to hedging risks, foreign exchange risks increase the levels of volatility and uncertainty that a business face. To this end, the performance of a business as recorded in the financial statements is dependent on factors that influence foreign exchange rates such as geopolitical events, market sentiments, and fiscal decisions, among others. Consequently, a business exposed to foreign exchange rates finds it challenging to accurately predict its future financial performance.
Translational Approaches
The two common approaches to translational financial statements are the temporal method and the current rate method. In the current rate method, the accountant translates the balance sheet and the various income statement items at the current exchange rate as of the reporting date (Chan, Landry, &...